The RSI explained simply
On a scale from 0 to 100, the RSI shows whether a price has mostly risen or fallen recently. Above 70 counts as overbought, below 30 as oversold. On its own, that's no buy signal.
The RSI is one of the best known indicators there is. On a scale from 0 to 100, it shows whether a price has mostly risen or mostly fallen over the last few days. RSI stands for Relative Strength Index.
What the number means
A high RSI means there were mostly up days recently. A low RSI means down days dominated. You'll find two lines drawn in almost every charting tool: above 70 counts as overbought, below 30 as oversold.
An example: Tom is watching a stock that has risen almost without a break for ten days. The RSI is at 78. That only tells him the rise has been very one sided lately. It doesn't mean the stock has to fall now.
How it's calculated
You look at the last 14 days. From the days the price went up, you work out the average gain. From the days it went down, the average loss. Then you divide one by the other and turn the result into a number between 0 and 100.
With numbers: the average gain is €1.20, the average loss is €0.60. The ratio is 2. The RSI is then 100 minus 100 divided by 3, so about 67.
What signals traders read from it
- Overbought and oversold: When the RSI drops below 30, some traders hope for a bounce. When it rises above 70, some expect a pullback.
- Divergence: The price makes a new high, but the RSI doesn't. That can hint that the rise is running out of steam.
- The middle at 50: If the RSI stays mostly above 50, up days dominate. Below 50, down days do.
Where it misleads you
In a strong trend the RSI often stays above 70 or below 30 for weeks. If you trade against the trend every time, you lose again and again. The chart below shows such a case: on the right, the RSI sits in overbought territory for over a month, and the price keeps rising anyway.
On top of that, the RSI only uses past prices. It knows nothing about news, earnings or the state of the company. It describes what has happened. It doesn't predict what comes next.
An example trade with made up numbers
Anna has €10,000 in her account and risks at most 1.5% per trade, so €150. A stock falls from €50 to €44, and the RSI is at 24. Anna buys and sets her stop loss at €41. Because she risks €3 per share, she buys 50 shares for €2,200. She pays a €1 fee to buy and another to sell, plus a spread of about 5 cents per share.
If it works: The price recovers to €50. Anna sells and is €300 ahead. After €2 in fees and about €5 in spread, roughly €293 is left.
If it goes wrong: The price keeps falling even though the RSI is already below 30. The stop triggers, but because the move is fast, she only gets out at €40.80. That's a €160 loss, about €167 with costs.
Whether the trade was a good one depends less on the RSI than on one thing: Anna knew beforehand the most she could lose. That's what saves her in the second case. More on this in the lesson on position size.
J. Welles Wilder introduced the RSI in 1978 in his book “New Concepts in Technical Trading Systems”. It compares average upward moves with average downward moves over a period, 14 periods by default.
The formula is RSI = 100 − 100 / (1 + RS). RS is the average gain divided by the average loss. Wilder smooths both averages in a particular way: the new average is the old one times 13, plus today's value, divided by 14. That makes the RSI react more gently than a simple average would. Some tools use simple averages instead, which is why two programs sometimes show slightly different values for the same day.
The levels 70 and 30 are a convention, not a law of nature. Some traders use 80 and 20 to get fewer but clearer signals. Shorter periods such as 7 days make the RSI jumpier, longer ones such as 21 days calmer.
Whether RSI signals make money over time after costs is disputed. Many simple rules that look good on old data lose their edge once spread, fees and slippage are added. The RSI works better as a description of the current situation than as the only trigger for a trade.
Summary
- The RSI describes how one sided a price has moved recently.
- Above 70 or below 30 doesn't mean the direction is about to turn.
- In strong trends the RSI often stays in extreme territory for weeks.
Did you get it?
A stock's RSI is at 78. What does that tell you?
That the price has mostly risen recently. Whether it falls next, the number doesn't say.
Why is an RSI below 30 not a reliable buy signal?
Because in a downtrend the price can keep falling for a long time while the RSI stays low.
What is an RSI divergence?
The price reaches a new high or low, but the RSI doesn't. That can hint at fading momentum.
Sources and further reading
- J. Welles Wilder: New Concepts in Technical Trading Systems, 1978.
- StockCharts ChartSchool, Relative Strength Index. View source ↗
- ESMA, investor information on trading risks. View source ↗
Related
- IndicatorsLearn Trading
- Limits of indicatorsLearn Trading
- Position sizeLearn Trading